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Raising the Excise Tax on Cigarettes: Effects on Health and the Federal Budget

CBO has analyzed the impact of a hypothetical increase in the federal excise tax on cigarettes to demonstrate the complex links between policies that aim to improve health and effects on the federal budget.

Summary

The federal government spends roughly $1 trillion on health care programs each year, so it is easy to imagine that policies that promote a healthier population could have a significant impact on the federal budget.

This study uses a policy to discourage smoking as an example for estimating the overall impact on the federal budget of a policy intervention to improve health. Specifically, CBO analyzed the budgetary effects of a hypothetical increase of 50 cents per pack in the federal excise tax on cigarettes and small cigars (from $1.01 to $1.51 in fiscal year 2013, with the increase adjusted each year to keep pace with inflation and, in the long term, with the growth of people’s income).

Of course, if lawmakers were to consider raising that federal excise tax—or adopting other policies that would promote a healthier population—their decisions would most likely depend on various considerations besides the effects on the federal budget.

Through What Channels Could Policies to Improve Health Affect the Budget?

Besides any direct impact on revenues and spending, a policy that aimed to improve health could affect the federal budget indirectly through the following links:

The effects of the policy on people’s behavior,

The impact of changes in behavior on people’s health, and

The implications of improvements in health for people’s health care spending, life expectancy, and earnings.

To produce comprehensive estimates of the budgetary effects of such a policy, CBO must assess the magnitude of each of those complex links. To the extent that better health reduced annual health care spending per capita, the costs of federal health care programs (including Medicare, Medicaid, and various smaller health care programs) might be lower than they would be otherwise. But to the extent that better health led to greater longevity, the number of beneficiaries of federal health care programs—and thus the programs’ costs—might rise. The magnitude of those countervailing effects could vary for different health care programs.

At the same time, improvements in health would increase outlays for programs that pay benefits to retired people (such as the retirement portion of Social Security) as greater longevity increased the number of people collecting benefits.

A reduction in smoking could also increase people’s earnings and hence the amount of federal revenues collected from income and payroll taxes.

Estimating the budgetary impact of federal policies that affect the health of the population inevitably involves considerable uncertainty. In this study, uncertainty arises from the inherent challenges in making budget projections under current law and from the many estimates of the effects of an increase in the cigarette tax that CBO produced in its statistical analyses and distilled from the research literature. Budget estimates become even more uncertain the farther they go into the future.

What Effect Would an Increase in the Cigarette Tax Have on the Federal Budget Over the Next Decade?

CBO’s analysis suggests that increasing the excise tax on cigarettes in the manner described above would reduce federal budget deficits by a total of about $42 billion through 2021 (the end of the 10-year period covered by CBO’s standard budget estimates when this analysis was conducted). Additional excise tax receipts would generate almost all of that reduction; health-related effects on outlays and revenues would be very small. (All of the effects on the federal budget deficit reported in this study refer to the primary deficit, which excludes the impact of interest payments on federal debt.)

Additional revenues from the higher excise tax (including partially offsetting effects on income and payroll taxes) would total $38 billion between 2013 and 2021, according to estimates by the staff of the Joint Committee on Taxation. Improvements in health that allowed people to work more and be more productive would boost labor earnings and add roughly another $3 billion to revenues over that period.

Spending on the government’s largest health care programs, Medicare and Medicaid, would be slightly lower as people’s health improved, and spending on Social Security would be slightly higher as more people lived longer. Those changes would be very small relative to the size of the programs (about 0.01 percent or less of each program’s projected outlays through 2021), and the net reduction in federal spending would be less than $1 billion over that period.

What Effect Would an Increase in the Cigarette Tax Have on the Federal Budget Over the Long Term?

Over the longer term (through 2085 in this analysis), the policy’s effect on people’s longevity would play a growing role, and federal spending would ultimately rise relative to the amounts projected under current law. The increase would continue to be very small, however, compared with the size of the programs involved. The largest total increase would be for Medicare, and even in 2085, that increase would represent less than 0.1 percent of the program’s total projected spending in that year.

On net, the illustrative tax increase would reduce federal budget deficits by small amounts throughout the long-term projection period, primarily because of the additional excise tax receipts (see figure below).

By themselves, the effects of improvements in health (including greater longevity) on revenues and outlays would have the net result of reducing deficits for roughly the next 50 years (see figure below). After that, however, the increase in spending (spurred by greater longevity) would start to exceed the increase in revenues stemming from better health. Whether positive or negative, those health effects on the deficit would always be very small—less than 0.01 percent of the nation’s gross domestic product (GDP)—and they would always be outweighed by the increase in revenues from the higher excise tax.

If lawmakers weighed raising the excise tax on cigarettes, their decisions would most likely depend on various considerations, including the effects of the policy on people’s health and mortality rates, views about the appropriate role of the government in influencing behavior, the burdens that the policy might impose on people in different circumstances, and the policy’s effects on the budgets of state and local governments. Such other considerations are beyond the scope of this analysis, which addresses only the impact on the federal budget (with related analysis of the effects on health and longevity).

Similarly, if lawmakers considered other policies to promote a healthier population, their decisions would depend on a number of considerations in addition to the budgetary impact. Moreover, the effects of other health-improving policies on the federal budget might differ substantially from the effects of the increase in the tax on cigarettes analyzed in this report.

How Does This Study Differ from CBO Cost Estimates for Policies to Discourage Smoking?

In the past few years, CBO estimated that several proposed policies to discourage smoking would decrease federal outlays for Medicaid by reducing the number of low-birth-weight babies (who have higher-than-average health care costs) born to women enrolled in Medicaid. (Versions of those policies have since been enacted.)

This analysis of the budgetary impact of an antismoking policy is more comprehensive than such cost estimates in several respects:

It includes new estimates of effects on average annual health care spending per capita and on longevity,

It considers the effects on a wider range of federal programs and sources of revenue than are included in traditional cost estimates,

It provides estimates for the longer term as well as for the 10-year period typically considered in budget estimates, and

It does not make the assumption, usually made in cost estimates, that the proposed policy would have no impact on GDP.

This analysis highlights the extent of the data and research that are necessary to produce such a comprehensive estimate of the budgetary impact of a proposed policy to improve people’s health. For most such policies that lawmakers might consider, the available data and research are much sparser than they are for an increase in the excise tax on cigarettes.